China reforms, theory and practice

By William Overholt

On Nov. 12, the third plenary session of the 18th Central Committee of the Chinese Communist Party (CCP) announced a major turn to market-oriented policies: interest-rate and currency liberalization, reform of banks and state enterprises, clearer land ownership for rural inhabitants and a better deal for urban migrants.

Behind this landmark decision was a potential crisis. China’s success has been driven by cheap exports based on cheap labor, infrastructure built by state enterprises with low-cost bank funding, and government budgets funded by land sales.

However, labor is no longer cheap, road construction to connect major cities has given way to building large shopping malls in small towns and land sales based on rezoning are reaching both economic limits and the limits of villagers’ tolerance.

The solution is a rapid shift from China’s export-based growth model to one based on domestic demand; from infrastructure to consumption; from the dominance of large state-owned enterprises (SOEs) to that of small and medium-sized businesses; from industry to services; and, more broadly, from bureaucratic control to market control.

All successful Asian countries have made this shift; Taiwan and South Korea are models. However, rapid change entails immense pain. SOEs will lose their low-interest loans, subsidized land, monopoly protection and privileged housing. Party and state bureaucracies will lose power (and income).

Local governments are particularly desperate. They have huge debts, which they amortize by rezoning and selling land. Already squeezed by exorbitant property prices and popular resistance to land takings, they now face higher interest rates, property taxes, villagers empowered by stronger rights and expensive new requirements to provide social services to migrants. The desperation of local potentates and SOE executives has created powerful resistance to reform.

At a plenary session reportedly marked by acrimony, China’s political leaders sided with reform. As one economic planner said, when asked about resistance before the decisive meeting: “In the end, all of our leaders understand numbers. The implications of the numbers are clear.”

The third plenum’s announcement of its decisions took the form of a statement of broad principles, leaving many observers concerned by the lack of detail. However, the CCP’s role is to set the direction of policy; executing the party’s decisions is the government’s job. And the plenum did establish a top-level group to coordinate and enforce implementation of its decisions.

While implementation will be a long struggle, with occasionally fierce resistance, key reforms are already underway. The current 12th Five-Year Plan calls for annual wage increases to average at least 13.4 percent; this year, wages are rising at an average rate of 18 percent, which will squeeze out industries characterized by obsolescence or overcapacity. Moreover, the government’s anti-corruption campaign is targeting some of the most powerful industry groups, such as the petroleum faction, thereby weakening their resistance to reform.